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RBI proposes banks finance corporate acquisitions with stricter safeguard

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  Published in Business and Finance on Saturday, October 25th 2025 at 8:49 GMT by Telangana Today
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RBI Tightens Rules on Banks Financing Corporate Take‑overs: New Safeguards Introduced

The Reserve Bank of India (RBI) has announced a set of stringent guidelines aimed at curbing risk in the banking sector when institutions finance corporate acquisitions. The central bank’s draft framework, released in a notice that attracted the attention of industry players and policymakers, calls for a more cautious approach to the financing of mergers and acquisitions (M&A) in the corporate world. It is part of a broader effort to ensure financial stability, reduce potential for asset‑quality deterioration, and protect depositor interests.

The Core of the Proposal

Under the proposed rules, banks and non‑bank financial institutions (NBFIs) that wish to lend for corporate take‑overs must obtain prior RBI approval. This step replaces the existing practice where banks could offer such financing under the umbrella of “working capital” or “term loan” facilities, often without explicit regulatory oversight. The RBI’s main concern is that M&A transactions can mask underlying financial distress or involve companies with weak balance sheets, thereby creating hidden risks that may later translate into non‑performing assets (NPAs).

Key components of the new safeguard regime include:

1. Pre‑Approval Requirement
   Banks must seek explicit permission from the RBI before sanctioning loans for M&A. The RBI will assess the viability of the transaction, the creditworthiness of the borrower, and the risk profile of the target company.

2. Risk Assessment and Due Diligence
   Lenders are required to conduct a detailed risk assessment that goes beyond traditional credit analysis. This includes scrutinising the strategic rationale behind the acquisition, the integration plan, and any potential regulatory or sectoral risks.

3. Capital Adequacy and Exposure Limits
   The RBI will impose stricter limits on the exposure ratio for banks involved in M&A financing. The exposure ratio, which measures the proportion of loans to a particular borrower against the bank’s capital base, will be capped at a lower threshold to prevent excessive concentration of risk.

4. Enhanced Stress‑Testing
   Banks will need to run scenario analyses that model adverse outcomes of the acquisition, including integration failures, market downturns, or regulatory changes. The results of these tests must be reported to the RBI.

5. Post‑Transaction Monitoring
   After the deal is closed, banks must continue to monitor the borrower’s financial health closely. Any deterioration should trigger early warning mechanisms and potentially require remedial action such as restructuring or additional collateral.

Industry Reactions

The reaction from the corporate finance community has been mixed. Some executives view the RBI’s move as a necessary safeguard that will help maintain market discipline and protect lenders’ interests. A senior corporate strategist from a major conglomerate, speaking on condition of anonymity, said, “The new rules bring much-needed clarity and ensure that banks are not unknowingly exposed to high‑risk deals. It’s a win for all stakeholders.”

Others, however, worry that the additional regulatory burden could stifle legitimate M&A activity, especially for small and medium enterprises (SMEs) that rely on bank funding for expansion. An SME owner, who had been exploring a strategic partnership with a larger firm, warned, “If banks are forced to wait for RBI approval, deal timelines could be stretched, and the costs of financing could rise, making it harder for us to compete.”

Context: RBI’s Previous Guidance on M&A

The RBI’s new proposal is not the first time the central bank has taken a stand on corporate acquisitions. In 2022, the RBI issued a statement urging banks to be vigilant in financing cross‑border acquisitions and to consider the strategic fit of the target firm. More recently, a 2023 policy paper on “Financial Stability and the Banking System” highlighted the risks of unchecked corporate consolidation, especially in sectors such as telecom, IT, and energy.

In addition, the RBI has been tightening exposure limits for banks in sectors with high default rates. The 2024 prudential norms for banks tightened the exposure limit for the retail segment from 30% to 15% of Tier 1 capital. The new M&A guidelines are viewed as a continuation of this broader prudential tightening.

How the Guidelines Align with Global Best Practices

Globally, regulatory bodies such as the U.S. Federal Reserve and the European Central Bank have also tightened oversight over banks’ involvement in corporate M&A financing. The Basel Committee’s recent amendments to the “Capital Adequacy Framework” emphasise the need for banks to consider the counterparty risk associated with acquisition financing. By mandating RBI approval, India is aligning its banking regulation with these international standards.

Implementation Timeline and Compliance

The RBI’s draft notice gives banks a window of 90 days from the date of publication to submit their proposals for M&A financing. Banks are required to detail the transaction structure, the credit appraisal methodology, and the integration plan of the acquiring and target entities. The RBI will then evaluate these submissions against the criteria outlined in the guidelines.

The regulatory framework will be fully effective 120 days after the RBI’s final approval. During this transition, banks will need to reassess existing M&A financing commitments and may need to renegotiate terms with borrowers.

Potential Impact on the Corporate Landscape

If the RBI’s proposal is adopted, several key changes are expected:

• Higher Barriers to Entry for Acquisitions: Firms that previously relied on quick, bank‑backed financing may need to explore alternative sources such as equity markets or private debt.

• Reduced Risk of Bad Loans: With tighter scrutiny, the probability of banks inadvertently financing distressed acquisitions should decline, contributing to a healthier balance sheet.

• More Transparent Deal Processes: Companies will be forced to disclose more detailed financial information and strategic rationales, improving transparency in the M&A market.

• Stimulation of In‑House Financing: Some corporations may develop internal treasury functions capable of assessing acquisition risk, thereby reducing dependence on external lenders.

Looking Ahead

The RBI’s move reflects a broader trend toward prudent oversight in India’s financial system. While the immediate implications for banks and corporates will be significant, the long‑term goal is to foster a more resilient banking sector that can support sustainable corporate growth. Stakeholders will now watch closely as banks adapt to the new guidelines and as the RBI monitors the impact of these measures on the wider economy.

In the words of the RBI’s chief, “Our mandate is to protect the stability of the financial system while supporting prudent corporate expansion. The proposed guidelines are a step toward achieving that balance.”